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Summary

  • The strategic movements of the company will allow it to grow revenues as well as cash flows over the next few years.
  • Improved cash flows should result in enhanced dividend growth going forward.
  • The payout ratio of the company should improve as the operating cash flows are expected to grow at a faster pace.

Duke Energy (NYSE:DUK) is one of the highest dividend yielding energy utility companies - yielding around 4.3%. The company conducts its business operations in three segments: Regulated utilities, International energy and commercial power. Over the last ten years, the company has reported substantial revenue gains, including several strategic decisions in the shape of mergers and acquisitions. Notably, Duke spun-off its natural gas division into a separate entity, Spectra Energy (NYSE:SE), near the end of 2006. These measures have enabled the company to generate consistent revenue streams along with hefty dividend payouts to the shareholders. In this article, we have tried to analyze the growth in dividends and operating cash flows. Moreover, we have tried to gauge the sustainability of growth in dividends through the prospects of its business segments and growth in cash flows.

Growth in Dividends

Duke Energy is well positioned to deliver strong and sustainable dividends to its shareholders in the coming years. The company has a consistent history of distributing increased dividends to its shareholders since 2007. Currently, the company pays an annual dividend of $3.12 per share and the average annual growth for the last five years stands at a decent 2.3%. Moreover, the company also increased its operating cash flows substantially by 19% over the last five years.

(click to enlarge)

Source: SEC Filings

The sustainability of dividends is usually gauged by the payout ratio - my preferred method is payout ratio based on free cash flows. The payout ratio based on free cash flows for the company stood at 257% in the last year, which implies that the company distributed more cash to its shareholders than its free cash flows. However, the robust growth in operating cash flows will ensure improved payout ratio and dividend sustainability in the future. The dividend performance of Duke Energy is quite strong amongst its industry peers such as Dominion Resources (NYSE:D) and Southern Company (NYSE:SO), illustrated in the table given below:

Dividend per share

Average Growth in Five years

Average Growth in Operational Cash Flows

Free Cash Flows (billion)

Cash Dividends (billion)

Payout Ratio

Duke Energy

$3.12

2.3%

19%

$0.856

$2.203

257%

Dominion Resources

$2.4

6.5%

8.33%

-

$1.319

-

Southern Company

$2.04

3.8%

18%

$0.634

$1.828

288%

Source: Morningstar and SEC Filings

Duke Energy has lagged behind its peers in the average annual dividend growth. This is mainly due to the strategic decisions by the company's structure. However, the company still manages to report a substantial annual growth in its operating cash flows which is comparably higher than its industry peers. Moreover, merging with Progress Energy will further ensure the increase in the operational efficiency of the Duke Energy. Over the last year, the company reported a gain of $4.34 billion due to the inclusion of Progress Energy operational benefits. The company is also focusing on delivering attractive returns to shareholders through sustainable dividends and operating cash flows.

Future Growth Prospects

The dividend sustainability of an energy company is measured by the increase in its operational throughput reflected by its efficient utility generation processes. Duke Energy has been making efforts in order to increase its regulated business exposure and revitalizing its international business segment. The company has planned to focus on completing its fleet modernization program and it has achieved constructive outcomes in rate cases. Duke has completed its $9 billion fleet modernization program over the last year. This program will add approximately 6,600 Megawatts [MWs] of new combined cycle natural gas and reduced-emission environmental friendly coal capacity in North Carolina, South Carolina and Indiana. Moreover, the company's nuclear fleet increased its operational efficiency and achieved a capacity factor of 92.8% in the last year. This will substantially increase the production resulting in amplified operating cash flows in the coming years.

Duke Energy has managed to provide reliable and affordable utility services through its coal facilities in the past. However, the increasing environmental safety regulations have affected the coal industry. The company has also started reducing its coal dependency over the last three years - reducing coal utility generation by 32% during the period. However, Duke Energy hedged itself from the commodity risks and relied heavily on oil and gas as utility generation sources - increasing oil and gas utility generation by 1480% over the last three years. Moreover, hydroelectric and solar generation sources have also been vastly adopted by the company. The U.S. shale revolution will benefit the company in the long-run with increased and readily available local utility generation sources.

(click to enlarge)

Source: SEC Filings

Duke Energy is also progressing on its international business segment which mainly includes 4,600 MWs of utility generation in Latin America, about half of which is hydro-generation in Brazil. This operational segment will be a major source of revenue - accounting for 10-15% of company's revenue mix and has been a solid performer till date. Moreover, the company is strategically reviving its international business segment while assessing strong growth prospects to achieve its targeted 4- 6% earnings per share growth rate. Duke Energy is targeting $16-20 billion of growth investments for the period from 2014 through 2018. These projects will lead to increased revenues in the coming years which will eventually increase the cash dividends to the shareholders.

Conclusion

We believe Duke Energy is well-positioned to grow due to its recent strategic moves. The company will be able to grow its revenues and cash flows over the next few years through expansions. As a result, the company will be able to return more cash to its shareholders. We believe Duke Energy is a good stock to add to a dividend portfolio.

Additional Disclosure: This article is for educational purposes only and it should not be taken as an investment recommendation. Investing in stock markets involves a number of risks and readers/investors are encouraged to do their own due diligence and familiarize themselves with the risks involved.

Source: Should You Add Duke Energy To Your Dividend Portfolio?